Twilio - Q1 2023

Transcript

Operator (participant)

Hello, welcome to the Twilio first quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star one on your telephone keypad. I will now turn the conference over to Bryan Vaniman, Senior Vice President, Investor Relations. Please go ahead.

Bryan Vaniman (SVP of Investor Relations)

Thanks, Sarah. Good afternoon, everyone, and thank you for joining us for Twilio's first quarter of 2023 earnings conference call. Our prepared remarks, earnings press release, investor presentation, SEC filings, and a replay of today's call can be found on our IR website at investors.twilio.com. Joining me today for Q&A are Jeff Lawson, Co-founder and CEO, Elena Donio, President, Twilio Data & Applications, Khozema Shipchandler, President, Twilio Communications, and Aidan Viggiano, Chief Financial Officer. As a reminder, some of our commentary today will include non-GAAP financial measures and key metrics. Reconciliations between our GAAP and non-GAAP results and further information related to guidance, definitions, and key metrics can be found in our earnings press release and the appendix of our prepared remarks, both of which can be found on our IR website. The information provided and discussed today also include forward-looking statements, including statements about our future outlook and goals.

These forward-looking statements are subject to known and unknown risks, uncertainties, assumptions, and other factors that are described in more detail in our most recent periodic reports filed with the SEC, including our most recent annual report on Form 10-K and our forthcoming quarterly report on Form 10-Q, which are available on our website and at sec.gov. Forward-looking statements represent our beliefs and assumptions only as of the date such statements are made. Actual results may vary significantly, and we expressly assume no obligation to update any forward-looking statement except as required by law. With that, I'll hand it over to Jeff for some opening remarks, and then we'll open the call for Q&A.

Jeff Lawson (Co-Founder and CEO)

Thank you, Bryan. You know, before we hop into the call, I wanted to really take note of three things today. First, I wanted to note this, that the substantial actions that we took in Q1 are working. As you can see from our strong non-GAAP operating profit results, one quarter in, we're really starting to show the profit potential of this business. We're also one quarter into our new structure. As you can see from our Q2 guide, we're looking into continued headwinds as we build the sales capacity of our Data & Apps business and doing that in a very tough macro environment as well. The good news is I see our leadership role continuing and even expanding in this environment, and I don't see things like changes in our churn or us losing share in the market.

I see moderation in our consumer-facing usage patterns, as well as us lapping our peak crypto usage from last year. These are some of the headwinds that we'll talk about. Through all this, what I really want to do is to thank the Twilio team. We've been navigating a lot of change over the last quarter, and I see Twilions every day navigating these changes with grace, with energy, and understanding of the job that is to be done here. It's truly energizing for me and for the rest of the leaders of the organization. That's really truly the Twilio magic in action. Thank you. Second, I'm sure this is on people's minds. The AI platform shift is upon us. Like the PC to web transition, the web to mobile, this is the next major technology shift in our society.

Working with customers, we see many ways to activate customer data in Segment across the whole customer life cycle using artificial intelligence. We'll have more to say about this during the course of this quarter and of course, at SIGNAL in August in terms of products, in terms of partnerships, and in terms of customer use cases. Really looking forward to that. The third thing I wanted to mention today, and lastly is, go Dubs. On to your questions.

Operator (participant)

Thank you. If you have a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, simply press star one again. Your first question comes from the line of Mark Murphy with JPMorgan. Please go ahead.

Mark Murphy (Executive Director)

Thank you very much. A question for Elena. You mentioned being in a strong position to actually re-accelerate bookings later this year. Khozema, in their prepared remarks, you're mentioning optimism in being able to re-accelerate growth as the year progresses. I'm wondering if you can just shed a little light on what is underpinning that positive thought process, and could it mean that Q2 might mark a bottom actually for the revenue growth rate or a local bottom for the revenue growth rate?

Elena Donio (President of Twilio Data and Applications)

Hey, Mark. It's Elena here. I'll start, and then I'll pass it over to Khozema for some commentary on the communications business. First, you know, let me just kind of walk you through the path to here to provide some context and groundwork for what's to come. First of all, I joined the company a year ago, exactly this week. At the time, Jeff asked me to sort of rearchitect and rebuild our go-to-market muscle and motion. What that meant was two things. One more substantively impacted communications and one on the data and application space. We realigned, rearchitected our sort of resource map and went through some of the big cost-cutting initiatives that you've seen, and you're starting to see the results of that.

That was primarily around our go-to-market muscle in the comm space. At the same time, we were sort of reinvesting in the data and application space. The job there has been to rebuild and grow our talent base there. We had You know, early in 2022, we had turnover, some attrition, some changes in how we set up the sales team, which we then unwound and began to rebuild from there. That rebuilding effort has taken us the last few quarters. We're now fully hired for the most part, but we're not fully ramped. We're all over that over the next couple of quarters, is getting that field organization, both at the AE level and the manager level, fully ramped.

Right now, our big focus isn't on enablement. It's on getting those reps from kind of their first deal to their 10th deal, we're really showing sort of what that team is capable of. Several of us are just back from our delayed sales kickoff, where it was very much a training-focused event and an enablement-focused event. Having spent a bunch of time with our people across the last few weeks, I feel really comfortable about the team that we have in place. That's a big reason for optimism, as you asked. I think, you know, we're also doing all of this work during a pretty tough macro time, as we've also talked about. We're seeing evidence of that in two areas.

We've talked in the past about things like cycle lengths, average selling prices, conversion rates across the funnel, and a little bit of contraction. We're definitely seeing all of that at the same time that we're rebuilding, re-engaging, re-energizing a field organization. With all that said, I just wanna close out with the things that give us real optimism. Number one, that Jeff talked about in his kickoff, we're seeing sort of great customer wins amidst all of this. I had a couple in my prepared remarks. Cricket Wireless, who is a current Twilio customer, became a Segment and Engage customer. Webhelp, a large BPO becoming a sizable Flex customer. We've had a couple of other really key wins in the financial services space across this quarter and last.

We're seeing great strides there, as well as great strides in our innovation agenda. Our product teams are really taking down a lot of the roadmap, delivering a lot of new capabilities from Segment Unify to Flex Unify, which ties together Flex and Segment with some customer wins across each of those as well. Team, just our enablement journey is in full swing. Our product delivery is in full swing, and bringing down some pretty exciting customer wins. Those are the things that give me faith that we'll begin to see ourselves climbing out of the trough that I think was in part self-inflicted, as we talked about throughout last year, and in part driven by the headwinds in the economy. I'll let Khozema talk about the corollary on the comms side.

Khozema Shipchandler (President of Twilio Communications)

Hey, Mark. What I would say is first of all, I totally echo Elena's enthusiasm about the path ahead here. I think there's a lot to be excited about. Our sales kickoff was at the same time, we kinda did them together, there's a lot of energy among the sales rep force. Just to maybe go to that first. First of all, sales rep productivity remains quite high. As Elena mentioned, you know, we did a lot of work on cost structure, even in spite of that, I think we feel very, very good about rep productivity. Second thing is that we are maintaining share in what continues to be a tough kinda macro environment. You know, we feel good about, like, a lot of our most recent customer wins.

You know, we talked about two deals in the script specifically where, you know, they were our largest ever on email and silent network authentication. I think those are indicators that, you know, customers are continuing to win with our customers. They're continuing to grow with us, albeit at slower rates than where they were. Third, and perhaps most importantly, especially as you look at our financials, is, like, we have a really tough comp relative to last year. You know, crypto was really outsized in the way that that part of, you know, the impact in our business grew, and we're kinda hitting the peak points as we're lapping that.

I think just naturally as we come out of the next couple quarters, you're gonna see just some natural acceleration in the growth rate as a result of that. I would hesitate to call it bottom. I mean, it is very dynamic, obviously. I don't think we're necessarily prepared to say that, but I think we're very, very excited about the setup for the back half of the year, and especially with our energy with customers.

Mark Murphy (Executive Director)

Wonderful. Thank you so much.

Khozema Shipchandler (President of Twilio Communications)

Thanks, Murph.

Operator (participant)

Your next question comes from the line of Meta Marshall with Morgan Stanley. Please go ahead.

Meta Marshall (Managing Director)

Great, thanks. Appreciate it. I just wanted to. You know, you mentioned kind of anniversarying peak crypto, but if you could just give a sense of, you know, what verticals you're seeing the most headwinds. Just on the communication side, like, what does reduced marketing budgets mean? Is that we cut certain use cases? Do we just kind of send fewer emails? Is it just simply from a reduction in transactions? I think just as we try to kind of think about how to model a recovery, just trying to get a sense of how those use cases, or the bounce back would evolve. Thanks.

Aidan Viggiano (CFO)

Hi, Meta. This is Aidan. I'll start, I'll hand it over to Khozema. Just to talk about some of the industry headwinds, we've called some of them out in the past, and we continue to see headwinds persist on the social side, consumer on demand, e-commerce, and in particular, crypto. Those continued in the quarter. As it relates to crypto, again, as Khozema said, we saw volume peak on our platform kind of in the Q2, Q3-ish timeframe last year, and that's creating a few hundred basis points head when year-over-year on the road. Khozema, I'll hand it over to you.

Khozema Shipchandler (President of Twilio Communications)

Yeah, I mean, I would largely echo, what Aidan said. I mean, I think as she mentioned, crypto was pretty significant last year. As we lap that

We feel pretty good about our ability to come out of that. I think the marketing spend that we referred to was much more on kind of the customer side, if you will, not necessarily on our side. You know, obviously some of our products end up serving use cases that are marketing related. As customer marketing volumes have come down a little bit, you know, frankly, that impacts both sides of our business to a degree. It honestly impacts probably the communications business a bit more significantly upfront. You know, we talked about the dynamics, and Nina. I mean, you know the company really well, you know. On the way up, like we react very, very quickly, and on the way down, unfortunately we react very, very quickly.

As things kind of moderate, I'm really optimistic that we'll be able to come out of it pretty fast. Otherwise, it's kind of business as usual. I mean, Aidan called out some of the industries, but otherwise we continue winning, we continue expanding, and we continue to maintain our share. We're not seeing really any pricing pressure out there either. Feel pretty good otherwise.

Meta Marshall (Managing Director)

Great. Thanks.

Operator (participant)

Your next question comes from the line of Michael Turrin with Wells Fargo Securities. Please go ahead.

Michael Turrin (Managing Director and Software Equity Research Analyst)

Hey, great. Thanks. I appreciate you taking the question. Just on guidance and what's assumed, given there are a number of moving pieces mentioned in the prepared remarks, can you just maybe walk through what you're assuming in terms of the macro and what you're seeing in expansion rates? Is this a consistent environment that's assumed? Then just also thinking through the progression of some of the go-to-market improvements that you're making, is there a way for us just to think about the timeline and progression of where expected benefits from those might start to play through? Thanks very much.

Aidan Viggiano (CFO)

Yeah. I'll start with a bit on the second quarter. This is Aidan, by the way, go a little bit into some of the traction for the year. It's largely macro as you think about the second quarter. The market continues to be pretty dynamic, and we're feeling the impacts of a broader slowdown. You see that reflected in our guide. I think the other thing that's important to remember is that the majority of our revenue comes from our communications business, about 85% of our revenue. As Khozema just said, that's a consumption model tied to consumer activity. In that business, we are dealing with a combination of macro as well as the tough comparisons that we just talked about on crypto.

Again, that's creating a headwind year-over-year as it relates to the second quarter growth rate. On the data and application side, Elena's talked about it as well, but we are rebuilding. Elena talked about our efforts there to ramp up the sales force and really enable the team further. We're also doing that in a tougher macro cycle. I'd say on the communication side, it's a combination of macro, some tough comparisons. On the software side, it's a mix of our efforts to rebuild plus some macro, and we factored all of this into our guide. I'd say some choppiness on growth in the short term, but despite that, you know, we're focused on what we can control, which is delivering profit in any environment.

As we think about the rest of the year, you know, we're gonna continue to guide quarter to quarter. We're not gonna guide beyond the second quarter at this point. Again, given the fact that most of our revenue is communications and usage-based makes it a little bit tougher to call. In light of that, we'll continue to plan conservatively, guide quarter to quarter. I think the other thing to consider is, you know, as the macro recovers and the consumption-based model comes back, you know, our growth will improve, our EBITDA will improve alongside it, and we'll be well positioned on the other side with a much more efficient cost structure.

Michael Turrin (Managing Director and Software Equity Research Analyst)

I appreciate the detailed answer. Thank you.

Operator (participant)

Your next question comes from the line of Ryan MacWilliams with Barclays. Please go ahead.

Ryan MacWilliams (Software Equity Research Analyst)

Thanks for taking the question. Just one housekeeping piece. How much potentially is the potential sale of your IoT business, potentially taken out of the second quarter guide? Are there any products or geographies where you're currently de-emphasizing revenue as part of these go-to-market changes? Thanks.

Aidan Viggiano (CFO)

This is Aidan, Ryan. Thanks for the question. As it relates to the sale of our IoT business, it's a relatively small contributor on revenue. It's in kind of the mid to high single digit millions. We'll provide some more of that as we go forward. It will be adjusted out of our organic calculations going forward as well, so you'll get an apples to apples comparison on revenue growth. A relatively small contributor overall. As it relates to any specific regions, no plans to de-emphasize revenue in certain geos.

Operator (participant)

Your next question comes from the line of Ittai Kidron with Oppenheimer & Co. Please go ahead.

Ittai Kidron (Managing Director)

Thanks. My question is for Elena. I was wondering if you can kind of double-click on the Data & Applications business, and more specifically, when you look at the growth of the unit in the quarter, help us understand what products are growing faster versus below this average, Segment, Engage, Flex, marketing. Which ones are growing faster than the 19% you delivered versus lower? Since we don't have the historical data on this, maybe you could talk about what deteriorated the most over the last two, three quarters and what part perhaps you expect to recover the fastest over the next two, three quarters. Thank you.

Elena Donio (President of Twilio Data and Applications)

Sure. We don't break out product by product. Just I'll remind you a couple of things. One, a number of these products are new, so the unified product, Engage, like a lot of those things have only been in market for from months to a handful of quarters. We're excited about the momentum and the progress, but we shouldn't expect to see those meaningfully impact the Twilio Data & Applications business units revenue in the very near term. Again, we won't be breaking that out product by product. I would just say and reiterate something I said earlier, that the real path out of... the real path to re-acceleration, the real path out of this deceleration comes down to two things.

Number one is making sure that our team is in seat and enabled. We're putting a lot of emphasis on that. Number two is just playing through the tough macro environment and really making sure that we're setting ourselves apart from what's happening in the competitive landscape and ensuring customers that even in a time of belt-tightening, this is a really good investment and it makes each of your marketing dollars work harder. To me, this question earlier, that's really what we're playing for right now. At the end of the day, like I would say a lot of the same themes are hitting both our Flex and Segment products largely. We're working on ramping and building the team to work through that.

Ittai Kidron (Managing Director)

When you look into the next quarter guide, is there another significant step down assumed in this business from a year-over-year growth standpoint? This business was not impacted by crypto, so I'm just trying to understand the drag on the next quarter. How much of that is the Communications business versus the Data & Applications business?

Aidan Viggiano (CFO)

Yeah. Hi, Ittai. This is Aidan. I'll take that. We don't provide guidance by business unit on revenue. As you think about the second quarter, you can generally assume that the slower growth is attributable to both businesses. Though, I would say given the much larger size of communications, it obviously has a bigger impact on our consolidated growth.

Ittai Kidron (Managing Director)

Thank you.

Operator (participant)

Your next question comes from the line of Taylor McGinnis with UBS. Please go ahead.

Taylor McGinnis (Equity Research Analyst)

Yeah. Hi. Thanks for taking my question. Just looking at the 1Q rep. 1Q rep declined sequentially and the 2Q guide, I think even if you strip out IoT assumes something similar. I know you mentioned that there hasn't been much change in churn, can you just provide more color on the drivers there? It seems like it might be some seasonality, but if that's the case, as we look throughout the rest of the year, any other seasonal patterns to keep in mind?

Aidan Viggiano (CFO)

Yeah, I'll start here and then if Elena and Khozema want to add, they can. You're right on. Churn overall has been, you know, relatively consistent. Where we are seeing some impacts is we are seeing a bit higher contraction again, really we think due to just lower spending on the part of our customers and we attribute that to the macro. On the expansion side, we are seeing that at a bit lower rates than where we've been ex-historically. Again, we think that's customers being budget conscious, scrutinizing their spend and, you know, that's really a function of the macro. The one area where we are seeing a little bit of an impact on new business, Elena's already talked about it, but is on the data and application side.

As she has mentioned, you know, we expect to gain traction there over the year as we ramp our sales force, and we expect bookings to re-accelerate towards the end of the year. That just gives you a little bit of color. In terms of how to, you know, think about revenue for the rest of the year. We're gonna continue to guide quarter to quarter just given how dynamic the macro is. Only a thing I'll call out, which we have already, is that we do have some tough comparisons here in the second quarter.

Elena Donio (President of Twilio Data and Applications)

I would just say just a little bit more color on contraction for Twilio Data & Applications. I think the good news there is that when we see contraction, it is not that we're seeing competitive loss or competitive takeouts and things like that. It's really just customers belt-tightening, their marketing spend going down or their transaction usage, for example, on Segment or utilization on Segment just going down because they're contracting. We take heart in the fact that, you know, the product is extremely valuable, extremely usable. They're, you know, as customers are going through tough times of their own, we see that show up in some of the contraction numbers that we're seeing.

feel good competitively, but we've got obviously a contraction happening that is a newer dynamic over the past few quarters.

Taylor McGinnis (Equity Research Analyst)

Appreciate the additional color. Thanks.

Operator (participant)

Your next question comes from the line of Derrick Wood with Cowen. Please go ahead.

Derrick Wood (Managing Director)

Great, thanks. This is for Khozema. You know, one of the questions we had was whether growth and consumption from the base would be impacted by the sales restructuring, since you were taking so many reps out of that business. Given the net revenue retention rate down at 106%, how much of that pressure is coming from the macro versus how much is kind of the pullback in your own growth investments? You know, as you look at a few months into your new low touch structure, what do you feel like is working well? What do you feel like you'd like to see some improvements on?

Khozema Shipchandler (President of Twilio Communications)

Yeah, that's a good question, Derrick. I would say in general, I would attribute it almost all to macro. I think the reduction in investments that we made on the sales and marketing side, I think that they were difficult decisions obviously, that we went through. Obviously there was impact to employees and, you know, we feel bad about that. I do think that with Going into it and now with the benefit of hindsight that it was absolutely the right thing to do, and that we're seeing the benefits of the efficiency. You can see those fall through to the bottom line. I think in terms of any impact on DV&E and or overall growth, like, we're just not seeing it right now.

What I would say is working is that, you know, kind of in this BU structure, I think having reps aligned to a certain set of products that are very tightly aligned to an economic buyer on the other side that matches the product set, I think that has been hugely impactful for our business. I know Elena Donio would say the exact same thing about her business as well. I think adopting this BU structure in that way is proving to be very, very useful. I think the two other things that I would call out specific to communications is as a result of those reductions, we tilted much more towards a self-service, product-led growth-oriented go-to-market motion. I think we're definitely seeing a lot of early successes there.

You know, there are various aspects of the experience, like onboarding, like compliance, like cross-selling, like getting additional products into the bundle, that we're just working on making a lot easier for customers so that they can adopt, you know, Twilio really, at a speed that they want to be able to operate at versus us at, you know, having to gate any of that. I think that's been quite good. I'd say, you know, we probably tilted a little bit more towards marketing dollars versus, you know, kind of rep-oriented dollars. I think that's worked pretty well too. It's obviously all a work in progress still, but I feel really good about where things are headed and cautiously optimistic about where things are going for the back half of the year.

Derrick Wood (Managing Director)

Got it. Thanks for the color.

Khozema Shipchandler (President of Twilio Communications)

Thanks.

Operator (participant)

Your next question comes from the line of Nick Altmann with Scotiabank. Please go ahead.

Nick Altmann (Director of Software Equity Research)

Yeah. Thanks, guys. Just building on Derrick's question, it sounds like you guys haven't seen much pressure on the growth side of the equation from the Communications side, from the headcount reduction, and some of the go-to-market changes. I'm just wondering, can you maybe parse out for us, like, how significant those changes were on the Communications side? I mean, I know you guys have talked about, you know, sort of this reversion to low touch model. But is there any way to sort of give more granularity around, you know, what's the split of quota-carrying reps focusing on, you know, Data & Applications versus Communications? Just as that sort of progresses throughout 2023, how will you guys sort of measure that impact and make changes, so to speak?

Like, if the communication side sort of sees further growth decel, will you start to sort of, you know, allocate more reps to that side of the business? Just any more granularity around that would be super helpful. Thanks.

Khozema Shipchandler (President of Twilio Communications)

Sure. This is Khozema. I can start the answer, and then if Elena wants to add some additional color, she will. I think what's important to remember as we went through the restructurings that we did over the last six, eight months is that they were almost entirely impacting the communications business. There were impacts to other G&A categories, but otherwise they were almost entirely impacting the communications business. As you think about the cost that came out of the business, it was really largely out of communications.

In fact, you know, to say it a little bit differently, in the Data & Applications business, as Elena mentioned in some of her remarks earlier, in fact, what we're trying to do is make good investments right now because we see a really big opportunity going forward, and we think we'd be remiss, quite frankly, if we weren't investing through this cycle. You know, in a way, like we're trying to optimize for profit on the Communications side while continuing to optimize for growth on the Data & Applications side. We haven't historically given a split of rep count or anything like that, like between businesses or how that splits necessarily between products. What I would say about that, though, is we did definitely make reductions in rep count as it related to our Communications business.

I mean, that was part of kind of getting ourselves much more towards a self-serve oriented motion. We retain reps on strategic accounts, obviously those that are kind of larger spenders, more enterprise-like. We continue to grow our rep count in the Data & Applications business. Hopefully that provides you with some additional color. I can't go exactly there in terms of the rep split.

Elena Donio (President of Twilio Data and Applications)

I would just add because you know, Khozema and I partnered on this together and we started orchestrating this move when I was still in the head of go-to-market role. Like I would say we looked at what is the ROI of each cohort of sellers and supporting roles within the go-to-market organization, and really took a close look at where, you know, a rep in was yielding discontinuous growth. Where it wasn't, we cut that out, and we made a concerted effort to make sure that sort of everywhere we're at injecting human capital, we're seeing a return for it. Sort of that's how I think about the fitness level that we've created across go-to-market now in both communications and Data & Applications.

Khozema Shipchandler (President of Twilio Communications)

Yeah. I guess just the last thing I would add, Nick, is that, you know, in spite of all these changes that we've kind of undergone in communications business, we've maintained share. Customers have stayed on the platform. We haven't seen any elevated churn and, you know, we continue winning with some really material accounts. That to me is a significant number of proof points that things are moving in the right direction. There's obviously more work to do, but

You know, starting off the year with strong profitability, which is kind of where we were oriented was really important for us. Now, you know, the rest of it is execution.

Nick Altmann (Director of Software Equity Research)

Great. Thank you.

Operator (participant)

Your next question comes from the line of Samad Samana with Jefferies. Please go ahead.

Samad Samana (Managing Director)

Hi, good evening. Thanks for taking my question. You know, I wanted to ask maybe on the software side of the business, and I was a little bit late, so I apologize if this has already been asked. Just as you think about I know you're investing for growth, but if you think about the booking trends, even as maybe customer spend on marketing is a little bit less, just how should we think about the changes and how that's driving maybe leads into the pipeline, the type of conversation that you're having? Is it changing the nature of where customers are viewing you versus just maybe the near term financial results which have been impacted by all the changes? I have a follow-up.

Elena Donio (President of Twilio Data and Applications)

Great. I'll take that. It's Elena here. We don't disclose our booking metrics, but we did say in prepared remarks and probably throughout the first question, that we are seeing headwinds of a couple different flavors. I think the first thing for you to take away is that of the sort of work we're doing to rebuild, reorient, and specialize the organization, like that work's still in progress. While we're making great strides there, we've hired the team, we've got dedicated sellers, in place for both Segment and Flex, and that's what makes up the Twilio Data & Applications business or the software business, as you called it.

The heads are in seat, but they're not fully ramped, and that's what we're working on over the next couple of quarters, is making sure that these reps are ramped and fully productive and have what they need to be successful. We're working through that. We expect to hit that stride over the next couple of quarters, but that we're also doing that during a tough macro time period. You mentioned marketing spend and things like that, and that is exactly the sort of customer messaging breakthrough that we're seeking to have, and making sure that customers continue to allocate budget to these kinds of things because we think that they're particularly helpful in this kind of a time where we're producing things like a return on ad spend that's higher than it would be without Segment.

That messaging's really important right now, but at the same time, we do see substantive, you know, like we do see headwinds from a macro perspective. Customers, you know, adding people to the sales cycle, adding approval levels, which will elongate sales cycles. We see a little, a small decrement in average selling price and things like that. We're playing through that period of time, but we feel good about the wins that we're seeing and the innovation that we're laying down in order to, number one, play through this time, but number two, prepare ourselves really well for as spend comes back online, we think we're first in line to go take it.

Samad Samana (Managing Director)

Great. Then maybe just a follow-up. There's been some scuttlebutt. Google recently was talking about rolling out something called Passkeys, which is meant to kind of limit the amount of 2FA that you need and/or changing just the nature of passwords in general and maybe accessing different apps and websites. I'm curious if you guys have any thoughts on maybe what the opportunity is for Twilio. I know 2FA has been a revenue driver in the past, and just how you guys are thinking about that and maybe what you're doing as how we get authenticated evolves over time. If you have any thoughts on that'd be great.

Jeff Lawson (Co-Founder and CEO)

Yeah, absolutely. Samad, this is Jeff. I'll answer that one. You know, the way I think about authentication these days is basically, you know, there's typically multiple forms. There's something you know, there's something you have, et cetera, and that's what we've come to understand as best practices for how to authenticate yourself. Passkeys are really evolving the evolution of passwords, right? They're easier to use. They're more secure. You can't reuse them. There's a lot of advantages to using this for instead of a password. It's like, almost like as if, you know, the computer is generating the password for you, as opposed to you having to type it in and remember it, is a way to maybe simplify the notion there.

What it doesn't do is provide you any information about who is this customer. Like, how do I identify them? How do I know who they are? That's things where like an email address or a phone number actually provide a notion of a person and their identity as opposed to just a way to have a shared secret or some way to reauthenticate yourself. These things typically work together. If you think about our Verify product, Twilio Verify is actually, you know, it does the identity verification of proving you are who you say you are, but it also does the work of saying, and this customer has this phone number, and therefore, like, I know who that is.

I can talk to them at that phone number. When they come back to me, I know who they are. I think that FIDO and WebAuthn, which, you know, Passkey is basically, you know, for all intents and purposes the same thing, it's a way of essentially presenting a password that is more secure, but it doesn't provide a sense of identity. Who is this person? Here's an email address, a phone number, something you can use to actually contact them and uniquely identify them in the world. That's what we offer.

These things actually work well together, and we've been evolving our offering in terms of, you know, things like Verify that offer silent network authentication, as well as other forms of identity verification, like through WhatsApp, all wrapped up into one really nice product, and that product is selling really well. If you'll see, we had a very large Fortune 100 entertainment company that we sold the largest Verify deal to, as well as a very large AI company that we sold Verify to in this past quarter. The product is selling very nicely, even in an environment where FIDO and WebAuthn have been getting a lot more traction for a number of years.

Samad Samana (Managing Director)

Great, Jeff. That's very helpful. Thank you so much.

Jeff Lawson (Co-Founder and CEO)

Absolutely.

Operator (participant)

Your next question comes from the line of Matt Stotler with William Blair. Please go ahead.

Alex Vasti (Equity Research Associate)

Hey, guys. This is Alex Vasti for Matt. Thanks for taking my question. I just wanted to speak about the partner channel. If you could talk to any updates you might have there, especially with the GSIs and the regional SIs. How are you enabling those partners? Do you have any thoughts on expanding the partner contribution going forward? Thanks.

Elena Donio (President of Twilio Data and Applications)

I will take that one. It's Elena here on the data and application side. We see a big role for partners both today and going forward. We've got a vibrant ecosystem of partners and particularly partners on the SI side. Not just global SIs, regional as well. I'd say that SI community is performing well in the Segment ecosystem as well as Flex. Those tend to be different partners. We also have a couple of others that I wouldn't necessarily put in the SI bucket, are, I think, pretty interesting for us today. Segment's a top partner within the AWS ISV Accelerate program, which connects AWS sellers into our sales process. We're seeing some good deals from that.

On the, on the Flex side, we've got several partners that sort of span just the SI world, but also, build product, side by side with Flex as well. You know, I'd say that we are... I've said over the past couple of calls actually that this is an area of focus and investment for us. I think we're seeing some good green shoots there. Lots more to do. I don't know if Samad has anything to add on the comms side. No, we're good.

Alex Vasti (Equity Research Associate)

Thanks.

Operator (participant)

Your next question comes from the line of Fred Havemeyer with Macquarie Capital. Please go ahead.

Fred Havemeyer (Senior Software Equity Research Analyst)

Hi. Thank you. I wanted to ask about some of the Segment wins that you were talking about there. I think the selection of customers was actually quite interesting. You have a healthcare company, you have a database company, you have a wireless company that has a more expansive relationship with Twilio. You know, could you talk about perhaps some of the use cases that these companies are using Segment for, and where those companies are finding value right now with Segment?

Elena Donio (President of Twilio Data and Applications)

You know, a thing that's super interesting, we talk a lot about B2C, there's definitely fantastic brands that are direct to consumer or have a big consumer element to what they do that are really out there working to find, identify, engage, acquire, and just better nurture those kinds of relationships in a way that is cost effective, really fast and pithy, and gives them the ability to do things that they can't do with their traditional kind of cobbled together CRM infrastructure. That said, we do have a percentage of our Segment customer population that's also B2B, some people that play in both B2B and B2C that are finding ways to sort of cross-pollinate their own channels and their own customer identities using the power of Segment.

We see customers do everything from sort of the core sort of data platform use cases and really using us for things that are, that are quite simple, but hard to pull off. Then we have, we have customers and a growing set of customers that are adding on capabilities, so Engage, for example, and our new Unify capability that we talked about in our prepared remarks. Those are a couple of things that we're doing. I think long game, we expect the Customer Data Platform to sort of be at the center, but for there to be a lot that we do with that. From the...

from Engage, for example, actually engaging your customers, getting out via our different communications channels to, utilizing Segment information to have better experiences with Flex in the call center or in a digital sort of in-app communication mechanism that a customer might be using with Flex. We see a ton of extension capability here, with that CDP as the center.

Fred Havemeyer (Senior Software Equity Research Analyst)

Elena, thank you. I think as a follow-up question, I was noticing that top 10 customer accounts are now down to about 10% of total revenue. I wanted to ask, is that a function of just diversification of Twilio's revenue base, or is there anything to read in there in terms of how your top customers are also trending their own usage of Twilio?

Aidan Viggiano (CFO)

This is Aidan. I'll take that. Yeah, it's largely a function of continued diversification. We're well diversified across industries, across customers, that continued. I'd say in terms of lower usage, we have seen that generally across the Communications and the D&A business, that's again, largely a function of the macro, as it relates to the top 10, it's continued diversification.

Fred Havemeyer (Senior Software Equity Research Analyst)

Thank you.

Jeff Lawson (Co-Founder and CEO)

You know, Fred, this is Jeff. This is Jeff. You know, you asked about some use cases for Segment, you know, I thought I'd expand because I think there's a few that are interesting that I thought would be worth sharing. One of the really cool things about Segment and having this customer data is, like a great platform, once the customer puts it in, I think they find that there are multiple, like many benefits of having the customer data in a spot, having it cleaned, having it good governance over it, and then ways in which you can activate it across many different parts of the customer life cycle.

you know, I was talking to a, you know, global Fortune 100 this morning about, you know, a Segment opportunity, and they rattled off like, you know, five different use cases from CRM to personalization across properties to tracking their customers across multiple acquisitions they had done, and knowing if a customer in one customer base was the same as a customer in another part of the customer base, so they could do more effective cross-selling and more effective retention of those customers. I think, you know, in M&A cases, for example, there are great opportunities because you have different identifiers for customers. You know, there's one customer that I think is a great, neat use case that I really like, which is they brought in Segment so that they could personalize their IVRs.

The idea was, you know, the thing they had seen was if you are trying to log in, say, to the website or a mobile app, and you know, consistently can't log in, like, you know, your password's not working, they can see that in real-time using Segment and flag your profile as someone who is likely, you know, having a password problem. When you call in, which probably at the scale of this customer happens, you know, I don't know, 100,000 times a day or whatever, they will put the first thing in the IVR is, "Having issues logging in? Press one." In which ordinarily, you have to go, like, 10 menus deep to get to that 1, probably. For you, because they saw your behavior on the website is clearly you're having trouble logging in, they dynamically reprogram that.

I mean, like, these are the kinds of use cases we see customers building across many different parts of their customer life cycle, marketing, sales, product, service support, that allow customers to serve their customers better. That's why I think data as a platform, in Segment is such a great product.

Fred Havemeyer (Senior Software Equity Research Analyst)

Aidan, Jeff, thank you.

Operator (participant)

Your next question comes from the line of Alex Zukin with Wolfe Research. Please go ahead.

Alex Zukin (Managing Director)

Hey, guys. Thanks for taking the question. I guess maybe just the first question is, the gross margins in the quarter were actually better, I think than we anticipated. I think they're the best performance in the last since Q1 of last year. You know, International didn't go down as a % of the total revenue. Was there something else that, you know, you're maybe walking away from business more that had a lower gross margin in the quarter? I know that we're not guiding to it, but at least from a trend lining perspective, how should we think about that? I've got a quick follow-up for Jeff.

Aidan Viggiano (CFO)

Yeah. Hi, Alex. This is Aidan. Yeah, it was 52.3% in the quarter, and that was up sequentially about 170 basis points. That was positive. Although I would say, you know, we'll continue to see variability on this line. It's largely a function of the mix of products and also within the messaging business, the mix of geography where the traffic terminates, which is a little bit different than the international percent of revenue that you're looking at, which is based on customer headquarters. What we saw this quarter relative to last quarter is there was a different mix in terms of where traffic was terminating, and that drove the better gross margin overall.

As we think about, you know, going forward and how to think about this, we're really orienting the business more to gross profit dollars and to gross margin rates, given the strong unit economics, in particular in the messaging business. So that'll continue to be our focus, as we move forward, is really orienting the team to gross profit dollar generation. As long as we can do that with the right cost structure, we think that's good business to keep doing.

Alex Zukin (Managing Director)

Got it. Then maybe Jeff, one for you. You talked about AI and generative AI with respect to Segment and CDP. I guess one common question we get is the notion of bidirectional messaging, conversational messaging seems like that trend is having a massive moment right now in the marketplace. Can you maybe talk about, you know, the puts and takes and the potential tailwinds to the communication side of the business from generative AI, what you're seeing in customer conversations that you're having existing or new around that?

Jeff Lawson (Co-Founder and CEO)

Yeah. Just to give you a quick backdrop, you know, I mentioned at the beginning of the call that, you know, generative AI is the next platform shift in technology. By the way, it's not in technology, it's actually in society. If you think about the... when these shifts occur, like the PC or, you know, the arrival of the PC and the PC to the web and the web to mobile, right? You can see the kind of disruption that occurs in market after market when these transformations happen. In fact, it's interesting, there was a Wall Street Journal headline today that says, you know, "Is this the iPhone moment?" I think absolutely, I would answer yes. Yes, it is. Now, there's an interesting question, though.

You know, if you remember the early days of, you know, say, the web, where companies were trying to figure out, "Oh, what do we do? Do we have a brochure on the site?" Remember when companies used to say, like, "We're not allowed to link off of our site because there's a legal problem with that." Everyone was like, "What?" People have to figure out how to use these new technologies in the corporate setting. I think that's what the conversations I'm having with customers now are exactly that, right? Is this ready for an enterprise use case? Or is a bot that I put in front of my customer gonna start, like, talking, saying stuff that I don't want it to say, right? Is it gonna start having a dialogue with my customers about, you know, God knows what?

Are they gonna stay on topic and talk about my products or my services and all that kind of stuff? I think that's where a lot of the work is going right now. I think those are really good questions that are getting answered, every day that work we are doing, work others are doing in terms of, like, how to keep these large language models on topic and provide boundaries for them so that they are useful in a corporate context. That stuff is getting resolved, I think, pretty quickly.

I'll put you into a conversation I had with a customer recently, which I think is indicative of what I think is going to happen. I was talking to a customer, a very large financial services company, and they were telling me how they had spent the last seven years building out all of the intents to have a bot for their service use cases that could contain, you know, customer calls, right? Containment is the, you know, it didn't have to reach a person. They said, well, this containment was, you know, after seven years of work or whatever, it was about 40%, and so 60% of the calls made it through to a human being.

I asked, and, you know, we were talking about large language models, and I said, you know, "Do you think you're going to keep that investment, or do you think you're gonna start from scratch in the large language model world?" The customer said, "No, we'll keep that investment, but, you know, hopefully, large language models will help us, you know, move it forward from 40% up from there." Through the course of the conversation, we talked a lot about what's possible and the architecture of these new language models and how they can work with Segment customer data and things like this.

At the end of the conversation, I asked again, "Do you think you're gonna keep that 40%, you know, the investment you made over the last seven years that got you to 40% containment?" The customer said, "No, it's going in the garbage can." Right? Like, every decision we've made for the last seven years about what's possible is now, like, a relic of the past and is up for relitigation and potentially new approaches, new vendors, new ways of implementing it because the large language model world just upends what is possible. I think that is why it is a gift in terms of creating new opportunities for companies, you know, like Twilio, who is helping our customers activate their customer data across the customer life cycle.

Take, you know, CRM, which has historically been this, like, kind of sleepy area of, like, just a database, not activate it, make it useful across many different touch points. Large language models are an absolute gift, and I'm very happy that we bought Segment when we did because the data that is in Segment enables a company to customize these interactions based on who they're talking to, the end user, the customer of our customer, and that is very powerful. Anyway, this is day zero of large language models, and you'll be hearing more from us in the course of this quarter. Obviously, we have SIGNAL in August, and I would not be a responsible technology leader if AI wasn't prominently a part of what we're talking about at SIGNAL.

We'll have more coming, and I hope everybody joins us at SIGNAL in August.

Alex Zukin (Managing Director)

Perfect. Thank you, guys.

Operator (participant)

Your next question comes from the line of Siti Panigrahi with Mizuho. Please go ahead.

Phillip Leytes (Equity Research Associate)

Hey, guys. It's Phil on for Siti. Thanks for taking my question. In your prepared remarks, you guys noted a Flex win with a major financial services company. Would love to learn a bit more about this win. Was it sourced through an SI partner? How well is Flex positioned to compete with the other CCaaS vendors?

Aidan Viggiano (CFO)

Yeah. A couple things. I don't believe that one was partner-sourced, but it's a deal we've been working on for a few quarters. It is a legacy takeout, and it is sort of a contact center specific use case. I would say, like, because you asked about Flex, that's really not our only use case. We're starting to see sort of a coalescing around three or four key things that we see really playing well in the market. First is sort of this in-app digital communication, in-app digital concierge, kind of capability, and we see a lot of great direct-to-consumer brands, utilizing Flex in that way.

Secondly is sort of a high-touch contextual sales kind of moment, and we see sort of large retailers and some other financial institutions playing in that area. Then lastly is sort of our core contact center use cases in the service and support area. This example that you mentioned happens to live right in that area, and that's the one that was in our prepared remarks today.

Phillip Leytes (Equity Research Associate)

Okay, thanks.

Operator (participant)

Your final question comes from the line of Michael Funk with Bank of America. Please go ahead.

Michael Funk (Managing Director)

Yeah. Thank you for squeezing me in here. Two if I could quickly. Aidan, one for you if I could. On the operating margin guidance for 2Q, I saw you called out a number of factors pressuring that sequentially. However, I would have thought the full quarter of the headcount reduction and potentially positive mix shift would have offset the reversal, for example, that you called out other things. Are there other factors going into that?

Aidan Viggiano (CFO)

Thanks for the question, Michael. We try to be pretty transparent about this in the prepared remarks because we are expecting profit to be down quarter-over-quarter. I gave a lot of information there, and I recognize it's a little bit counterintuitive given the timing of the restructuring in the first quarter. Let me just, like, walk through some of the pieces. And I'll talk about, you know, what will continue beyond the second quarter as well. First, the first quarter benefited from a $12 million one-time accrual reversal related to the sunsetting of our employee sabbatical program. That won't repeat in the second quarter or beyond. We guided to lower quarter-over-quarter revenues, which directly impacts our gross profit as well as our operating profit.

We expect a number of different cost items to be a headwind quarter-over-quarter. First, Merit goes into effect in the second quarter as it does every year, that will obviously go into effect, Q2 and for the rest of the year. We're moving some employees, we talked about this in the prior earnings call, but we're moving some employees to cash bonuses from equity-based awards. This is for a subset of our employee base, but it'll help moderate stock-based compensation, expense growth going forward. That in the period presents an OpEx headwind. We've also made some changes to our incentive compensation structure for the communication sales team to better align to Twilio's financial goals.

While that doesn't result in any difference in cash being paid to a specific sales executive, there's a bit of a difference in accounting in terms of what is incurred in period versus what is deferred over time. That creates a little bit of a headwind. Lastly, we do expect more normalized levels of marketing and travel spend in the second quarter. I'd say we're pretty light in the first quarter just post the reorganization. As teams were settling into the new structures, we just didn't spend as much as we had planned we would. All of those items more than offset the full quarter benefit of the restructuring actions that we announced in February. We're still guiding to 65-75.

We raised the low end of our guide for the year to $275 million-$350 million, and we're tracking really well, you know, to date.

Michael Funk (Managing Director)

That's very helpful color. I appreciate it. Thank you.

Operator (participant)

This concludes the conference call. Thank you for participating. You may now disconnect your lines.